Reaching the Pinnacle?

California Supreme Court Rules That CC&R Arbitration Provisions Are Enforceable Against HOAs

Matt J. Malone

This is the first in a two-part series on the Pinnacle case.  In this first part, attorney Matt J. Malone describes the nature of arbitration, the details and reasoning behind the ruling, and the issues and questions remaining now that Pinnacle is the law.  In the second part, attorneys Tyler P. Berding and Randolph M. Paul will discuss both the myths concerning arbitration and the reasons why not all developers or insurers will jump at the chance to arbitrate association defect disputes.

For the past several years, the Courts of Appeal in California have struggled with the enforcement of arbitration provisions in homeowner association Conditions, Covenants and Restrictions (“CC&Rs”).  These provisions waive an association’s right to jury trial in construction defect disputes against developers or converters.  And largely, the Courts of Appeal had refused to enforce them on the grounds that associations never consented to them and/or they were unconscionable.  But in August, the issue finally came before the California Supreme Court in the case of Pinnacle Museum Towers Association v.  Pinnacle Market Development (U.S.) LLC.  And the Court spoke clearly:  CC&R arbitration provisions are valid, enforceable and are not unconscionable under California law.

In order to provide a background for why enforcement of arbitration provisions is such a significant issue for associations, this article will begin by briefly discussing the arbitration process and its potential difficulties.  Then we examine the Pinnacle decision itself, to understand why the Court enforced CC&R arbitration provisions even though an independent, owner-controlled association never consented to them.  Finally, we take a look forward to examine the potential effect of Pinnacle on associations with defect claims, as well as what other consequences may arise from the Court’s decision.

Where have all the seismologists gone?

Italian Scientists found Guilty for failing to Predict Earthquake!

We see disasters all of the time--hurricanes, forest fires, floods, and earthquakes. Many of them damage community associations. But an Italian court just found 6 scientists guilty of manslaughter for failing to accurately predict the intensity of an earthquake that killed several hundred people in Italy several years ago. First of all, if I were a scientist in the business of predicting disasters--climatologists, seismologists, civil engineers--I would be tempted to make no predictions at all after this.

And what was accomplished, even setting aside the ridiculous idea that the intensity or even the date of an earthquake can be accurately predicted at all? Scientists will have to re-consider whether to leave the public without guidance of any sort, or to overstate the danger to avoid this same fate. Neither outcome benefits the public when prediction of most natural disasters is inexact at best.

It would seem that the prosecutors in Italy should have focused on the hundreds of ancient masonry buildings that crumbled and their owners who failed to properly retrofit them for earthquake safety.

Are Rental Apartments the New Condos?

 Will Developers Stop Building Common Interest Developments?

          If you check in regularly with the community association social media—blogs, Twitter, Facebook—you cannot miss the group of correspondents who have a decided bias against community associations. It’s not always possible to separate fact from fiction, or personal bias from social concern, but the message is clear—there are many people who don’t like their homeowners association specifically or the entire concept generally. Claims of over-reaching by boards of directors or managers; vendors who see community associations as a piggy bank; and professionals—attorneys especially—who are blamed for overzealous enforcement of the rules and regulations and foreclosures, are all listed as reasons why community associations are not a good thing, or maybe even unconstitutional!

          Of course, these commentators’ understanding of the legal framework of homeowner associations can be a little thin and hence their opinions often lack practical application, but the passion is clearly there. I have read many times that we should (somehow) restrict or ban this type of housing altogether. I can empathize with some of the frustration that they feel because it is obvious that community associations are often creatures of convenience for developers and municipalities rather than organizations with their eventual owners in mind. They are created under laws enacted by state legislatures that respond more to the notion that we need to build more affordable housing now than to the idea that it has to be practical to maintain and manage in the long run. Regardless, boards, managers, and vendors inherit the real-life responsibility for these projects no matter how flawed they may be in concept. 

          But for now, the pundits' prayers may be answered—at least for a little while. Rental, rather than owned, housing seems to be the real estate concept du jour. And of course, rental housing does not come equipped with a homeowner’s association. That’s not the same as banning them outright as some politically naïve souls might like, but it probably has the same practical effect—you will be able acquire affordable housing without the drawbacks of an association of owners to weigh you down and interfere with your constitutional rights.[i]  

San Bernardino, CA--Another Ponzi Scheme?

Cities are going bankrupt because they made promises they couldn't keep—will community associations be next?

            Vallejo, California declared bankruptcy in 2008. The city of Hercules defaulted on its bond debt repayments. In June, Stockton California filed for Chapter 9 bankruptcy. On July 10, 2012, the city council of the City of San Bernardino, California voted to file for bankruptcy. That's two major California cities seeking bankruptcy protection within the last 30 days. Other U.S. cities and counties have either declared Chapter 9  bankruptcy or are on the brink. Central Falls, R.I.; Harrisburg, Pa; Boise County, Idaho, and Jefferson County, Alabama all share that distinction.[2] Stockton may be the biggest city in the nation to declare bankruptcy.

            Each of these public entities has a unique reason for its financial problems. Base closings. Industry shutdowns. A gradual financial decline. But Stockton’s case is somewhat different and perhaps presages more accurately the fate of many other municipalities—they spent money they didn’t have and failed to determine if they ever would. 

          “The city's fiscal history "has eerie similarities to a Ponzi scheme," says Bob Deis, the city manager Stockton hired in 2010. Over the years, the city promised employees huge—and unfunded—salaries and benefits...”[3]

            Essentially, the Stockton City Council approved ever-higher salaries and pension benefits for public employees without the slightest idea of how these benefits would be funded.

            “Perched precariously atop this mountain of obligations are retiree health benefits. Stockton officials awarded these to city employees in a series of votes in the 1990s but made no effort to fund them, intending simply to pay costs out of their budget as workers retired…Stockton Mayor Ann Johnston voted for these expensive measures when she served on the city council. ‘We didn't have projections into the future what the costs might be…I learned that you don't make decisions without looking into the future’… ‘Nobody gave thought to how it was eventually going to be paid for,’ says Mr. Deis, the city manager. “[4]

               Why would public officials be so shortsighted? Part of the reason was political pressure from public employee unions--pressure that is being applied even today to prevent further job and salary cuts. But part of it is that is just too simple to satisfy present day political demands by borrowing funds from future generations--essentially kicking the funding debt down the road.

Exposed?!

What protects an individual homeowner from a catastrophic judgment against her community association?

    There’s a lot of media and blog space being devoted to the question of whether the homeowners in the community where Trayvon Martin was killed could end up personally responsible for a judgment obtained against their association and perhaps lose their homes as a result. This tragedy could certainly result in a lawsuit brought against the association by Martin’s family. If it were, it could be based in part on the fact that the homeowner’s association authorized the “neighborhood watch” program which included the work of George Zimmerman, Martin’s alleged assailant. A verdict of negligent supervision resulting in wrongful death could produce a judgment against the association. Notwithstanding all of the publicity and national attention, the damages in the case, assuming a finding of liability against the association, would likely be an award of general damages—a punitive damage award against the association is unlikely on these facts. But any damages award of a substantial amount against the association could create concern among owners about their own potential responsibility. Are the individual owners exposed to personal liability in that or similar scenarios?

Reform Community Associations?

After all of the rhetoric, what's really at the end of the rainbow? 

          There is a documentary film entitled "HOAX" which, according to the filmmaker,  Rodney Gray, "follows an investigative reporter, homeowners, and HOA reform activists as they reveal shocking evidence of financial and psychological hardships experienced by people throughout Texas and Nevada. A few of these people, including the filmmaker, have been the subject of adverse actions from the very HOAs created to help them."

The blogosphere has picked up this film and especially those sites which champion the rights of individual owners, have trumpeted it as revealing and a blow against injustice. I've looked at  the link to the teaser for the film and it appears that the producer has chosen several large gated communities as his subjects. While not agreeing with the premise of the film (i.e. that there is widespread abuse of owners by management companies and boards of directors) it is clear that there are problems out there. Some of the problems stem from very conservative (or liberal, depending on your point of view) reading of governing documents and the ensuing enforcement. We have all read the accounts of fines and foreclosures over  minor infractions. As the complaints mount and the blogs come alive with indignation over these stories, like everything else, the real question boils down to: "What, if anything, can you do about it?"

Ponzi Scheme?

Cities are going bankrupt because they didn’t  project their funding needs into the future—will community associations be next?

            Vallejo, California declared bankruptcy in 2008. The city of Hercules defaulted on its bond debt repayments. In June, Stockton California filed for Chapter 9 bankruptcy. On July 10, 2012, the city council of the City of San Bernardino, California voted to file for bankruptcy. That's two major California cities seeking bankruptcy protection within the last 30 days. Other U.S. cities and counties have either declared Chapter 9  bankruptcy or are on the brink. Central Falls, R.I.; Harrisburg, Pa; Boise County, Idaho, and Jefferson County, Alabama all share that distinction.[2] Stockton may be the biggest city in the nation to declare bankruptcy.

            Each of these public entities has a unique reason for its financial problems. Base closings. Industry shutdowns. A gradual financial decline. But Stockton’s case is somewhat different and perhaps presages more accurately the fate of many other municipalities—they spent money they didn’t have and failed to determine if they ever would. 

          “The city's fiscal history "has eerie similarities to a Ponzi scheme," says Bob Deis, the city manager Stockton hired in 2010. Over the years, the city promised employees huge—and unfunded—salaries and benefits...”[3]

            Essentially, the Stockton City Council approved ever-higher salaries and pension benefits for public employees without the slightest idea of how these benefits would be funded.

            “Perched precariously atop this mountain of obligations are retiree health benefits. Stockton officials awarded these to city employees in a series of votes in the 1990s but made no effort to fund them, intending simply to pay costs out of their budget as workers retired…Stockton Mayor Ann Johnston voted for these expensive measures when she served on the city council. ‘We didn't have projections into the future what the costs might be…I learned that you don't make decisions without looking into the future’… ‘Nobody gave thought to how it was eventually going to be paid for,’ says Mr. Deis, the city manager. “[4]

               Why would public officials be so shortsighted? Part of the reason was political pressure from public employee unions--pressure that is being applied even today to prevent further job and salary cuts. But part of it is that is just too simple to satisfy present day political demands by borrowing funds from future generations--essentially kicking the funding debt down the road.

Negligent Condo Conversion?

Is the converter liable for failing to properly assemble the parts of a new community?

The Conversion Cycle. The latest round of conversions of old apartment buildings to condominiums has come and gone. While the cycle was quick, no professional in the community association industry could have missed it. Numerous "new" communities were created from old apartment buildings during the five years of the late, great, housing boom. Why then? Because when not only is every piece of residential real estate selling as fast as it's listed, but when there is also a waiting list to buy new homes, you had to know that developers would start looking for something else to sell — perhaps something that didn't take several years to develop and build. Immediate inventory, if you will. Old apartment buildings are made to order. Add to that the fact that in such a super-heated market the value of an apartment is much greater if it can be sold as an individual parcel than if it is just one unit in a large rental complex, and you have the makings of another conversion boom.

I say "another conversion boom" because we have seen one twice before — in the early eighties and early nineties — and each time, at the tail end of an upswing in housing prices, numerous apartment complexes were converted to condominiums. The latest version just ended, and we probably will not see any further conversions for a long time. In less superheated real estate markets, buyers prefer new construction and will pay to get it until prices reach record levels and/or there is no new inventory to buy. When that happens, the housing market will temporarily support conversion activity again.

Basic Training Manual for Community Association Board Members

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Essential Information about Community Associations for New Volunteers 

Newly elected board members (and some that have been around for awhile) may not have enough information about the basic legal facts of their community association. This manual walks them through topics like these: "What are the types of common interest developments?" "What is an 'association' and what does it do?" "What are the responsibilities of board members?" "What legal authority governs common interest developments?"

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Condo Issues.com: Why Won't They Serve?

Condo Issues.com: Why Won't They Serve?: Homeowners won’t volunteer for boards of directors of community associations—another nail in the community association coffin? Click the title link to read the essay.

When Community Associations Lose "Critical Mass"

The Consequences to a Community Association of the Loss of Human Energy

By Tyler P. Berding, JD, Ph.D.

(Editor's Note: The following article comes from our historical file. It was first published in 1997. The message is equally applicable today--community associations which ignore proper management, fail to encourage owner involvement, and do not adequately fund for future repairs will deteriorate over time. This and various articles which followed became the basis for "The Uncertain Future of Community Associations" series of essays.)

            "Critical Mass" is a physics concept.  Basically, it is defined as the smallest hunk of matter that will sustain a nuclear reaction.  If the mass of the material is too small, it cannot generate heat or light.  When the mass is adequate, it can support a chain reaction that will continue to produce energy.  While it may be a bit of a stretch, we can also apply the critical mass concept to social phenomena.  A group must have enough people to produce the creative energy necessary to accomplish the goals of the group.  If the group is too small, it will not be sufficiently energized, and will fail to accomplish its purpose.  When this happens, members become disillusioned, and quit the group.

Excerpts From an Ongoing Debate

Do owners believe CCRs are contracts?
And why that doesn’t matter! 
By Tyler P. Berding, JD., Ph.D.

Editor’s Note: Evan McKenzie is an Associate Professor of Political Science at the University of Illinois at Chicago. He is also a lawyer and has written extensively on the phenomenon of private government as applied to housing. He has written two books entitled “Privatopia” and “Return to Privatopia” and he regularly posts on his blog, “The Privatopia Papers.” The following blog post by Evan and the responses below, contain both philosophical and practical points of view on the nature and future of community associations.  

Evan McKenzie’s Post:

I have been thinking about an issue raised in a post by Fred Pilot recently, and responded to by Tyler Berding in a comment. I will do both of them the injustice of oversimplifying their arguments so I can rush to make my own, and I invite them (and others) to reply and continue the conversation.

Fred argues that the American public generally does not consider CID declarations and other governing documents to be contracts. Fred has long held that Americans do not accept the basic concept of residential private governance. He believes that the general home-buying public rejects the notion that there is any real legitimacy in the decisions made by condo associations and HOAs. If I understand his position correctly, he is saying that Americans do not consider CID documents and decisions to be legitimate either in a public or a private sense. They are not viewed as the actions of de facto quasi-local governments, and they are not viewed as obligations people are bound to by private contract. They fall between two stools, as the saying goes.

Tyler responds that they are contracts, period, because that is what courts universally say they are. This is in large part beyond dispute: like it or not, condo associations, HOAs, and housing cooperatives are recognized by federal and state law, and CC&Rs and other CID governing documents are fully enforceable, subject to a few exceptions, in every court in the nation. What, then, is the point of claiming that people reject them as illegitimate? Isn’t that akin to saying that you reject the law, which you have to obey regardless of how you feel about it?

This is an important conversation, and I have been thinking about it for many years. At the outset, it has to be pointed out that it is logically possible for both positions to be true. Perhaps the American public believes that homeowner and condo associations have no legitimacy, but they obey their rules for the most part simply because they know those rules are enforceable. However, I think the truth is more complicated than this...